Wednesday, September 15, 2010

If you look on the bottom of this post Mish, you will see I beat you to the point on your article "The Worst is Yet to Come". In fact, I wrote a post called the Worst is Yet to Come that also was posted on this Chinese website.

In any case, I did my studies and I came to the same conclusion, 3 million extra homes built roughly. I used data that came out of the government and I couldn't tell you where because the links didn't come out.
The 1970's should have been near the peak in housing. The data I had only went through 2004, but I know that 2005 and 2006 were even higher because I was looking at Calculated Risk's site with all his good graphs.

If you figure 3 million extra homes, plus changing demographics and figure the government is going to cause another 400K a year to be built, we are looking at a 10 year oversupply. A 3% to 5% decline out of this is a joke, because debt is deflating and housing debt is a big part of it.

Another thing that is a lie is that current existing home sales are at an all time record. The NAR is a pack of liars who began keeping their own statistics in 2000. Home sales in 1981 dropped to 2 million and they weren't much higher in 1982. In fact, 4 million was the all time high prior to 1997.

We had a deflation in the 1980's, but it was bailed out by steadily falling interest rates and a speculative trend that supported home prices in a lot of areas. DFW had a hell of a housing bust, as it was one of the bright economic spots in the country in the early 1980's and everyone moved in to build. 200K units were built in 1983/1984 and the market suffered for 8 years, despite a growing population.

Home construction probably didn't fall to a reasonable level until early 2008, so we are only 2.5 years into this mess. Once people realize the bust has hit housing, there will be fewer piling in to get a bargain. Real estate in Japan fell 90% in some places, despite their government and central bank doing roughly the same as Obama and the Fed. DFW has a growing population or I doubt the bust would have ended prior to 2000.

We own lower end rental property, mostly in Plano, Tx. I can see the inventory building up in a lot of older areas. Plano has blue ribbon schools, so it is still a stable price area and land is running out quickly. But, we had the telecom bust in 2001, which took to top out of the market here. But, in 2007, SFR construction was running just short of 50,000 units a year. There is a huge inventory homes in the subdivisions I go through and we are at the end. Foreclosures here were running high before the bust hit and have declined significantly during the tax credit time.

Credit quality of renters has been bad for some time, probably because the subprime mortgage boom took so many of the good renters out of the market. But what is going on now is I can see that people are having trouble paying their rent. In the meantime, speculators have bought piles of houses from lenders and distressed sellers. So, there has been an outlet for inventory at the right price for awhile. I have to believe this is about to be saturated.

I get conflicting information. One of my mothers friends, who likes to think he is the second coming of Warren Buffet says he has been told they are selling all the strip centers they can sell here. I suspected they were merely getting new names on the line for expiring loans, but I also suspect someone is lying. I have a friend that is going to law school at age 44, but he made his living building apartment projects. He says there is no work out there and not much in the way of willing buyers. There was a lot of California money came in under 1031 exchanges tha bought properties at 4% cap rates when you could get 5% on 10 year treasuries. That is not only a huge bet on inflation, but a huge bet on occupancy as well. With vacancy, taxes, insurance and maintenance, returns that low can vanish and turn negative quickly. Whether these projects were leveraged or not, I don't know, but I do know I heard some high land price quotes floating around in the middle part of the decade.

My friend that built apartments told me in 2007 that guys he knew in the real estate business who never sold anything were selling out then. Not many people live long enough to go through a cyclical real estate bust or a bear stock market and those that have and made it to the other side, don't generally get caught twice. It costs a lot of money to sell real estate, not to mention the capital gains taxes, but it costs even more to get caught in a bust. The housing boom I mentioned in the 1980's, saw the demise of a lot of properties that were producing good income prior. They had to tear the stuff down because they couldn't rent it. The same was true of commercial with landmarks like the Republic National Bank Complex and several other big buildings being mothballed and sold at bargain prices. The Republic National Bank complex was around 2 million square feet and I recall it sold for $7 million, due in part to the asbestos removal that would need to be done. But it wasn't 5 years earlier the site would have cost that.

I have thought about this and I believe the first thing that needs to be done is the GSE's refuse to finance any houses started after today. This would force people to get private financing before they built and would restrict supply. The tragedy is that we are going to lose a generation of skilled construction workers, but we are going to lose them anyhow. Many will have to go back to Mexico and that will leave the work to the remaining skilled Americans. But, there will be a dearth of labor for this purpose when the time comes, which it will.

But, the problem is even deeper, as we now have a credit problem. Witness Japan devaluing the yen. This was more than trade problems, as the Japanese were using treasuries, which are the credit of the United States to creat yen. The world has been using the dollar and the US government to expand their credit base for over 50 years now and the credit game is running out. American housing and the resulting bubble was the last credit boom of this long cycle. The lower housing goes, the less credit will be created out of equity. This is not only how deflation works, but inflation as well. The housing bubble created its own fuel, as even resales freed credit to be used to fund bank accounts and buy goods and services and other assets, including housing. This phenomenon has reversed, not because people don't want to push it forward, but because it has reversed. This doesn't make sense I know, but the mere reversal is all that is needed to keep the reversal going. This happens because the growth in credit was propelled on itself and not by any specific act. The reversal removes the fuel that was driving it the last mile.

The chicken or the egg theory is a tough one, but I believe the entire inflation we have seen over the past started with the build up of cash balances out of the 1970's housing bubble. Homes doubled here in 3 years back in the late 1970's and there was land everywhere. Those cash balances went into the 1980's where they drew mid teens interest for 3 years and the high single digits for the remainder of the decade. This then fueled not only the stock market, but the next real estate boom when rates fell. Lower payments made houses more affordable to more people and more house affordable to those that already had one. The GSE's complied by reducing down payments to the point that double contracting became legal.

I recall selling a house for a young kid when I first graduated collee in 1979 who was able to get back every dime he put into it, including payments. He had only lived there a couple of years and the appreciation paid the sales expense as well. He took the money and moved to Oklahoma to go to college.

In reading Steve Keen's recent stuff, it is clear we have a huge vaccuum under asset prices around the world. Cash balances might seem high, but we are talking around 1/2 the GDP, which falls under the old 6 months in liquid assets theory. It isn't the existence of cash that drives asset inflation, but the increase in it. What lies under this cash is a lot of bad assets, which will not only consume the capital of intermediaries, but cause the reduction in the money supply as well. There can't be any more cash than there is assets behind the cash and the mere liquidation of the bad collateral will serve to consume the excess.

So with housing we will reach the ultimate paradox, the low down payments that have supported housing and the need for security in lending that will eliminate the low down payments. As cash gets more dear, there will be even fewer people with even a low downpayment.